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SECURING PERFORMANCE AND PAYMENT BY BANKS

by Tijana Arsenijevi

LL.M. SHORT THESIS COURSE: COMPARATIVE SECURED TRANSACTIONS PROFESSOR: Tibor Tajti Central European University 1051 Budapest, Nador utca. 9 Hungary

March 25 2010

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Table of Contents

Chapter I: Introduction........................................................................................................1

Chapter II: International scene ...........................................................................................5

1. USA ................................................................................................................................5

1.1. Legal environment .....................................................................................................5

1.2. UCC Art.9-building blocks ........................................................................................6

1.2.1. The unitary and comprehensive concept of the security interests .........................6

1.2.2. The system of priorities ...........................................................................................6

1.2.3. The floating lien concept .........................................................................................8

1.2.4. The filing system ......................................................................................................8

1.2.5. The enforcement system ..........................................................................................9

1.2.5.1. Creditor’s right of repossession ......................................................................... 10

1.2.5.2. Creditor’s rights of disposition and strict foreclosure ...................................... 10

1.2.5.3. Debtor’s right of redemption ............................................................................. 11

2. ENGLAND .................................................................................................................. 12

2.1. Banking legal environment ...................................................................................... 12

2.2. Publicity of security rights ....................................................................................... 12

2.3. Enforcement of security rights ................................................................................ 12

2.4. Types of available securities..................................................................................... 13

2.4.1. Fixed Charges ........................................................................................................ 14

2.4.2. Floating Charges ................................................................................................... 14

2.4.3. The Relevance of the Distinction........................................................................... 16

2.5. Practical problems with the concept on example of Book Debts ............................ 16

2.6. Further steps ............................................................................................................ 17

3. GERMANY ................................................................................................................. 18

3.1. Legal environment ................................................................................................... 18

3.2. Publicity of security devices ..................................................................................... 19

3.3. Enforcement of security rights ................................................................................ 19

3.4. Types of security devices .......................................................................................... 20

3.4.1. Land Charge (“Grundschuld”) ............................................................................. 20

3.4.2. German Security Transfer (“Sicherungs bereignung”) ...................................... 22

3.4.3. Fiduciary security assignment (“Sicherungsabtretung”) ...................................... 23

http://www.ebrd.com/pubs/legal/secured.pdfhttp://webjcli.ncl.ac.uk/2006/issue1/hanlon1.htmlhttp://studentorgs.law.unc.edu/documents.ncbank.volume9.laurenpogue.pdfhttp://www.researchandmarkets.com/reports/316374/serbia_banking_market_2006_cee_banking_series.htmhttp://www.nkosk.co.rs/code/navigate.asp?Id=5http://www.ius.bg.ac.yu/prof/Materijali/xivmil/NovoHipotekarnoPravoClanak.pdfhttp://www.rgz.gov.rs/template1.asp?PageName=ceh_opstihttp://www.apr.gov.rs/http://www.ria.merr.gov.rs/uploads/media/3.%20Namirenje%20iz%20zaloge%20na%20pokretnim%20stvarima%20i%20pravima.pdfhttp://www.sec.gov.rs/index.php?option=com_content&task=view&id=898&Itemid=71http://www.mtu.gov.rs/http://www.ehipoteka.pl/corporate_site/content/download/646/2521/file/zeszyt_21.pdf

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Chapter III: SERBIA ......................................................................................................... 24

1. Introduction................................................................................................................. 24

2. In personam security devices....................................................................................... 26

2.1. Suretyship ................................................................................................................. 26

2.1.1. Practical difficulties ............................................................................................... 27

2.2. Bank guarantee ........................................................................................................ 27

2.3. Bill of exchange......................................................................................................... 28

2.3.1. Practical implications ............................................................................................ 29

3. In Rem Security Devices .............................................................................................. 30

3.1. Security interests on Immovables ............................................................................ 30

3.1.1. Mortgage (Hipoteka) .............................................................................................. 30

3.1.1.1. Subject of a mortgage ......................................................................................... 31

3.1.1.2. Mortgage on object under construction............................................................. 32

3.1.1.3. Scope of the mortgage ........................................................................................ 34

3.1.1.4. Types and creation of mortgage ......................................................................... 34

3.1.1.5. Exception from accessoriness principle ............................................................. 35

3.1.1.6. Mortgage contract .............................................................................................. 36

3.1.1.7. Enforcement ....................................................................................................... 37

3.1.1.7.1. Extrajudicial enforcement ............................................................................... 39

3.1.1.7.2. The right of sale ............................................................................................... 40

3.1.1.8. Central mortgage register .................................................................................. 40

3.2. Security interest on movables .................................................................................. 41

3.2.1. Possessory pledge................................................................................................... 41

3.2.2. Non-possessory pledge ........................................................................................... 42

3.2.2.1. The unitary and comprehensive concept of security interests (?)..................... 43

3.2.2.2. Filing ................................................................................................................... 45

3.2.2.2.1. Content of filing ............................................................................................... 46

3.2.2.2.2. Exemptions from filing in the Pledge Registry ............................................... 46

3.2.3. Priorities ................................................................................................................ 47

3.2.3.1. Concept of proceeds ........................................................................................... 48

3.2.3.2. The priority of judicial, statutory and right of pledge by the State .................. 48

3.2.4. Floating lien? ......................................................................................................... 48

3.2.5. Enforcement .......................................................................................................... 49

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3.2.5.1. Creditor’s right of repossession ......................................................................... 49

3.2.5.2. Creditor’s rights - Disposition and strict foreclosure ........................................ 51

3.2.5.3. Debtor’s rights .................................................................................................... 52

3.3. Assignment of receivables ....................................................................................... 53

3.4. Investment Property................................................................................................. 54

4. Other Credit Enhancement Methods ......................................................................... 56

4.1. Negative pledge covenants ....................................................................................... 56

4.2. Subordination ........................................................................................................... 56

4.3. Right of set-off .......................................................................................................... 57

5. Importance of the other areas of law .......................................................................... 57

5.1. Importance of bankruptcy proceedings .................................................................. 57

5.1.1. Reorganization and rights of secured creditor ..................................................... 59

5.1.2. Voidable preferences ............................................................................................. 60

5.2. Consumer protection ................................................................................................ 60

Chapter IV: CONCLUSION .............................................................................................. 62

Bibliography ....................................................................................................................... 66

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Table of Abbreviations

BGB rgerliches Gesetzbuch (German Civil Code)

e.g. exempli gratia (for example)

i.e. id est (that is)

UCC Uniform Commercial Code

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ABSTRACT

This short thesis focuses on manner in which Serbian banks secure their claims when

granting credit. Since state of a legal system when placed in international setting, first chapter

elaborates on leading security devices of banking systems in USA, England and Germany,

since solutions known to these systems served as a basis for introducing changes to the

Serbian system. Chapter on Serbia elaborates on types of collateral required by banks in their

General Terms and Conditions, as well as novel possibilities of extra-judicial enforcement of

claims introduced by new set of laws. At the end of the chapter, complementary fields of

bankruptcy and consumer protection will be tackled in order to paint a full picture on the state

of Serbian secured transactions law. Finally, the thesis tries to evaluate state of current affairs

in banking practice and suggest possible ways of development.

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Chapter I: Introduction

Importance of the banking systems in promoting or facilitating economic

development is well elaborated by economists. Review of the essential functions of the

banking system reveals that these include its acting as an intermediary between savers and

borrowers and capability of increasing or decreasing a stock of money by supplying it to the

customers. Perhaps the most important function is an inherent one. By playing a significant

role in the process of credit supply, banks appear as real guides of entrepreneurial talent and

economy as a whole. This last function proves to be of the greatest importance to the

developing countries. In order for banks to “set the country on the road to continuing

growth”1 they need to act as agents eager to attract funds and allocate them to the

entrepreneurs and investments, rather than to just make use of their monopolistic position and

distribute loans to the unproductive projects2.

For banks to make credit more accessible and minimize the risk for non-payment it is

of a great importance to use a reliable instrument of security. Having been recognized as

crucial in the transition to free market economies, creating a well functioning security system

has become one of the major tasks for developing countries. Serbia is amongst the countries

that have recognized true potentials in reforming its collateral law and it is going through an

intensive transition period in order to comply with the requirements set by the European

Union.

1 “Banking and economic development some lessons of history”, edited by Rondo Cameron (New York Oxford University press, London 1972) at 8 2 See id. at 8.

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This thesis will provide an insight into what types of collateral Serbian banks usually

use, present their advantages and disadvantages and provide some future paths of

development and examples of the types of collateral that might be used. It will evaluate

whether Serbian banks utilize every type of asset that can be used as collateral so that they can

respond to the needs of a growing market.

During this evaluation, analytical approach to the legal reforms in Serbian security

system will be applied. It is easily concluded that the legal reform is anything but an easy

process of drafting borrowed concepts from the foreign systems. By now the practice proved

the crude implants of foreign law to be inefficient in domestic setting. In order for law to fit

the needs of a particular legal system, it has to be tailor-made by its legal experts and to

reflect local tradition and culture. This was the system adopted by Serbian legislators who

paid due respect to domestic legal institutes while adapting ways of improving the legislation

suggested by EBRD.

The new law incorporates features that were unthinkable before. Enforcement can, if

agreed by the parties, take place outside the judicial process, making it quicker and cheaper.

Lenders can accept a wider variety of assets as security, and pledges are recorded in an online

database. When borrowers default, lenders are allowed to seize the assets straightaway to

avoid losing them.

Features of the Serbian legislation will be examined according to their use by banks.

When elaborating on types of collateral utilized by banks, focus will be on assets required by

banks’ General Terms and Conditions when approving retail and business credits. Thus, this

thesis will not include possibilities of crediting on the account of retention of title and other

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types of title financing, which represent security interest in some jurisdictions.3 It can be

concluded that banks secure their claims in very much the same way, regardless of type of

debtor. Even though regulatory framework is set, especially with the enactment of Law on

Pledge of Movable Assets in the Pledge Registry, for a modern secured transactions law,

Serbian banks still heavily rely on “hard assets”, such as immovable’s, pledge on equipment,

deposits and bank guarantees.

State of Serbian collateral law will be examined in comparison with national

legislation on this issue in England, USA and Germany. Since confines of this thesis do not

allow for an overall elaboration on whole security spectrum granted by these laws, text will

focus on leading security devices of each secured transactions system. The comparative

approach with these countries is chosen precisely because they have established mechanisms

for securing credit that seem appealing to other countries as well. Most of the novel features

brought into Serbian collateral law was actually inspired by solutions existent in the above

stated counties. In attempt to provide overall picture of tendencies within secured transactions

law and role of banks in the above stated systems, with a special emphasis on Serbian banks

and legislation, structure of thesis will be as follows:

First chapter will make a short overview of the situation on the international scene.

Thus, within the chapter, under the title of the US law, attention will be paid to features of

Art. 9 of Uniform Commercial Code since it are considered to be a piece of legislation which

enabled utilization of all types of movables as collateral and enhanced the overall business

activity. Its unique features served as a role model for drafters of the EBRD Model Law on

3 E.g. According to UCC Art.9 conditional sales confer security interest. See Tajti ,Tibor Comparative Secured Transactions Law (Akademiai Kiado, Budapest,Hungary,2002)at 93

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Secured Transactions4 which largely influenced regulation of this field in CEE countries as

well as in Serbia. England, as another common law country, even though did not make an

influence on Serbian legislators, is chosen since its most powerful security device in form of

floating charge is very interesting to Serbian theoreticians and practitioners. Discussion on

German law security devices is included because it helps understanding of a logic of civil law

systems and proves that well – developed economy can be built on peculiar legal institutes

that are however, completely suitable to the needs of country in question.

Second chapter is devoted to types of collateral in use by Serbian banks. Special

emphasis will be made on changes introduced by Mortgage Act5 and Law on Pledge of

Movable Assets in the Pledge Registry6 which really brought difference within the field. At

the end of the chapter, surrounding areas of consumer protection and protection of secured

creditor in bankruptcy will be tackled.

Conclusion will evaluate achievements in the field and identify areas that may be

improved in the future.

4 See available at http://www.ebrd.com/pubs/legal/secured.pdf (last visited March,22,2010) 5 Published in “Official Gazette” No.115/05 6 Published in “Official Gazette” No 57/2003 and 61/2005

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Chapter II: International scene

1. USA

1.1. Legal environment

United States have definitely one of the most developed markets in the world. Its

financial structure can be described as a market-oriented one, as opposed to German bank

centered orientation. According to Dalgic market orientation can be said to express a

marketing perception that put customer in the center of all firms’ activities7. Market structure

with a varied scheme of creditors coupled with an ever-rising credit demand actually helps

boosting small businesses. Even though banks are not the only investors in the economy, their

position is backed up by a unique legislation on personal property securities which help them

utilize every conceivable kind of movable assets. This policy choice of legislator is still

having a very strong impact on the overall economic development in US because it enables

crediting small enterprises whose highest value can be obtained from their future business

activities.

Even though security spectrum known to US banks is very broad and includes all

types of securities, such as mortgage, possessory and non-possessory pledge over movables,

all sorts of personal securities, such as guarantees and standby letters of credit as well as other

credit enhancement methods8, such as subordination, covenants, comfort letters and right of

set-off, UCC Art. 9, devoted to regulation of security interests over personal property and

fixtures is something which really made US law of secured transactions stand out and lead

the way. This is the reason why features of UCC Art.9 are going to be described in more

7 Dalgic, Tevfik, Dissemination of market orientation in Europe: A conceptual and historical evaluation, (International Marketing Review, MCB UP Ltd, Vol.15, 1998) 45-60 8 Largely in use in practice, as opposed to civil law systems, including Serbia.

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detail, according to its building blocks9. Among other things, more room is going to be given

to this Code because its unique and comprehensive system of security interests made a large

impact on makers of EBRD Model Law which largely influenced modeling regulation on

secured transaction in CEE region as well as in Serbia.

1.2. UCC Art.9-building blocks

1.2.1. The unitary and comprehensive concept of the security interests

When thinking about main features of UCC Art.9, one cannot proceed without first

pointing out to its unique philosophy that enabled creation of the whole system. Its drafters

were practical enough to look beyond the form of secured transaction and look at the actual

function of particular security device. This kind of philosophy enabled putting together all

types of security interest in movables and fixtures, including sale under retention of title and

receivables financing and embracing them under the same concept of security interest which

led to a simplification of creating a security right over collateral. Art.9 does not distinguish

between various kinds of security and there are all subject to the same rules of creation of

security interests and filing. The best example of a complete departure from the pre-code,

formalist approach to the matter is inclusion of the same rules on perfection and priority rules

even for receivables financing, thus making them equivalent with other security devices10.

Furthermore, since this system is not based on numerous clauses concept, way for introducing

new types of security devices that will entertain needs of modern financing is open.

1.2.2. The system of priorities

Article 9 has a priority system which allows for special priority rules in addition to a

general first-to-file rule. These priority rules are in reliance with the philosophy of the US

9 Enumerated in Tajti at 141 10 However, rules of enforcement are different and apply to receivables only.

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secured transactions law which is to enhance credit life as much as possible. The consequence

of such policy is that two or more creditors may claim an interest in the same collateral and

additional purchasers of the collateral may appear also as having conflicting interests. In this

case, the security interests rank accordingly to priority received at the time of perfection or

filing. In case of conflict between unperfected security interests, the first to attach has

priority.11 However, it is just a general rule; in reality priority system is very complex and

depends on the type of the collateral, special priority rules etc. Most important priority rules

include protection of buyer in the ordinary course of business, the super-priority of purchase-

money security interest (hereinafter: PMSI) and priority of bank’s security interests in deposit

accounts.

As in most of the systems, protection of bona fidae purchasers in the ordinary course

of business is also embraced by the UCC, for a simple reason of facilitating free flow of

goods. This is especially important in an inventory financing arrangement.12

Priority of the PMSI is connected with the recognition of the after-acquired property

interest13. Reason for introducing such a priority right is seen in the fact that subsequent

financing contributes to the assets of the debtor as well as creditor who own the rights in the

after-acquired property14. Only requirements for enjoying this priority right is that it is

perfected either before debtor acquires possession over collateral or within 20 days.

A bank’s priority right in deposit account maintained by it supersedes any other

security interest in that account, with the sole exception of perfection by control15.

11 Attachment describes the point at which property becomes subject to a security interest. The agreement must be in writing, unless the collateral is in the possession of the secured party. 12 See UCC s. 9-307 13 See Gilmore, Grant Security Interests in Personal Property (Little, Brown and Company, Boston 1965) at 743, Chapter 28 14 See Tajti at 167 15 A secured party may obtain control over a deposit account through one of three mechanisms described in U.C.C. 9-104: (1) in case the secured party is the bank in which the deposit account is maintained; (2) if the secured party is authorized by the debtor and the bank to dispose of the funds in the account without further consent by the debtor; or, (3) if the secured party has become a customer with respect to the deposit account

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1.2.3. The floating lien concept

Even though US floating lien is only a concept as opposed to English floating charge,

which is construed as security device, it serves the same end of enabling long-term financing.

By covering after-acquired property, proceeds and future advances, floating lien substantially

simplifies granting new credit lines to the debtor. Perfection of floating lien is not different

from perfection of other security devices- it is done by filing a financial statement which only

has to contain “reasonable identification of collateral”16. Priority rights to a floating lien are

subject to basic “first in time rule” and subject only to a super –priority right of PMSI. Code

also allows debtor to continue doing his business and protects the floating lienee by providing

that his security interest will continue in collateral regardless of its disposition by debtor,

except if disposition was authorized by secured parties or disposition was provided for in the

security agreement17.

1.2.4. The filing system

“Ostensible ownership”18 problem is handled by UCC by recognition of perfection

methods as a main public notice mechanism. Filing is seen as a central perfection method

which allows creditors to make easy searches on encumbrances on assets accepted as

collateral19. When filing a financial statement, creditor has to only include names of the

(e.g. has been added as signatory to the account). Control can be said to serve the same end as possession in case of tangible personal property. 16 See UCC s.9-100 17 See Tajti at 179 18 Generally the ostensible ownership dilemma occurs where non-possessory security interests are involved. The debtor retains possession or control of the personal property subject to the security interest, but the secured party has in rem rights (the security interest) in the property. In some situations, possession or control, while not necessarily good evidence of ownership, may be the best evidence available. A third party, unaware of the security interest which doesn’t have the facilities to discover it is forced to rely on appearances, thus the ostensible ownership dilemma. The ostensible ownership dilemma is important in the secured transactions context because it can result in multiple competing security interests in one piece of property. Solutions offered for the problem differ in various systems, e.g. in US: focus is on public notice whenever a security interests exists while in Germany focus in the BGB is on numerous clauses of proprietary rights. 19 Other then filing, UCC recognizes other means of perfection a security interest such as perfection by possession, by control and automatic perfection in case of consumer goods, but filing is seen as the main avenue of perfection.

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parties and reasonable identification of collateral by type. This kind of filing is known as

“notice filing“ and it is said to reduce costs of filing which certainly suits business needs20.

Once made, filing is effective for five years, but a continuation statement can be lodged six

months before expiration21. Searches in the register can be conducted under the name of

debtor. Exempted from filing are consumer goods22, certain assignments of accounts23 and

beneficial interests in decedent’s estate24.

1.2.5. The enforcement system

Efficiency of enforcement system of US secured transaction is a feature that cannot

be solely attributable to Article 925. Even though a unique set of rules of self-help

enforcement plays a central role, it can be said that the actual option given to secured creditor

is a feature that makes the whole enforcement system successful26.This option enables him to

choose the best way of satisfaction of his claims and turn to courts in case the self-help

alternative does not work. Therefore, enforcement system is created as a four-pronged system

which consists of efficient bailiff system, efficient general execution system, self-help and

efficient provisionary measures27.

Since, present attempts of reforming systems of secured transaction regulations in

transition countries, including Serbia, guided by EBRD Model Law share the fascination with

UCC self-help method of enforcement, it is going to be described in more detail below.

20 Opposite to that is “transaction filing”, type of filing introduced by Serbian Registries. In case of “transaction filing“ the whole underlying document is enclosed along the financial statement with the filing body. 21 See s.9-522 RV UCC 2222 The reason for this exception is seen in requirements of economic efficiency. Security interest in consumer goods is perfected at the time of its creation. The only security interest still left to be filed is in automobiles. See Gilmore at 534-535 23 See UCC s.9-302 (e) (f) (g). This exemption is made for casual and isolated assignments. Other than that, general filing requirement applies also to assignments. See Tajti at 157 24 See s.9-309 RV UCC 25 See Tajti at 182 26 Ibid. 27 Ibid.

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However, one must bear in mind that it is not the one institute that make a system efficient, by

the overall structure surrounding it.

1.2.5.1. Creditor’s right of repossession

Creditor’s right of repossession is certainly seen as one of the major advantages

given to secured creditors under Art.9. It can be effectuated in two ways: by private

repossession and by action. When making use of granted right of private repossession,

creditors have to bear in mind the “without a breach of peace“28 standard which prevent this

vehicle to be seen as a creditor biased.

1.2.5.2. Creditor’s rights of disposition and strict foreclosure

Strict foreclosure is a legal proceeding aimed at terminating debtor’s right in

collateral by conferring title to a creditor, without first conducting a sale29. This type of

foreclosure certainly gives creditor short and efficient manner of enforcing a security interest

in collateral. However, this institute is not immune from problems that may arise in case the

value of collateral is higher than the amount of the loan. Being concerned with rights of the

debtor-borrower, who is prone to bringing rash decision when in need of money, legislator

imposed two limitations to the right of strict foreclosure. First one is a “60% rule“ which is

mostly applicable to consumer finance. This rule insists upon mandatory disposition of

collateral in which debtor built up equity by paying out 60% of a purchase price. Any surplus

from this sale should be ultimately returned to debtor30. The second limitation is provided by

28A clear definition of” breach of the peace” is not found in any state statue, much less in the UCC. In summary, it can be said that in case the collateral recovery agent (repo man) is faced with potential violence or physical confrontation, he must retreat without the collateral. In case he does not, he might face serious sanctions which might go as far as awarding punitive damages in favour of debtor. 29 See Black's Law Dictionary (8th ed. 2004) 30 See Tajti at 190

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the “proposal and objection” model, which is in principle available against all the creditors

that did not follow the detailed set of steps when making use if this advantage31.

In case the remedy of strict foreclosure is not viable for any reason, creditor may

dispose of collateral. If creditor decides to proceed with private sale, it has to be conducted in

a commercially reasonable manner32.

1.2.5.3. Debtor’s right of redemption

In case the debtor pays out the whole amount of debt due, increased by amount of

certain expenses, he might be able to redeem the pledged collateral. This right of debtor is

also valid against certain purchasers (except for buyers for value in the ordinary course of

business) in case disposition was conducted improperly33. Other than that debtor is also

protected by possibility of judicial review of creditor’s action or protection by provisions of

criminal law in cases of fraud. When the possibility of punitive damages and constitutional

protection in case of summary remedies34 is added, it can be said that secured transactions

system established by UCC addressed properly interests of debtor.

31 Ibid. 32 Examples from court practice consider sale of agricultural equipment during winter to be commercially unreasonable (First Interstate Credit Alliance, Inc. v. Clark 11 UCC Rep. Serv.2d 1012 (S.D.N.Y.1990)) 33 See UCC 9-504 (4) 34 See decisions in Fuentes v. Shevin 407 U.S. 67,92 S. Ct. 1983,32 L. Ed. 2d 556, re’l g denied; 409 U.S. 902 ,93 S. Ct. 177,34 L. Ed. 2d 165 (1972); Mitschell v. W.T.Grant Co. 416 U.S. 600,94 S.Ct. 1895,40 L.Ed. 2d 406 (1974)

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2. ENGLAND

2.1. Banking legal environment

England does not have Art.9 – like unified and comprehensive type of security

interest. Rather, it can be seen as a compartmentalized and incoherent system.35 It can be said

that the US approach is functional whereas the English approach is pragmatic36. Regulation

on secured transaction is scattered around various legal sources-statutes, judicial decisions

and scholarly writings. Accordingly, different rules apply to various kinds of security devices,

since more attention is given to the name of security than its function.

2.2. Publicity of security rights

Registration even though provides publicity for security rights is not seen as central

method of it. Thus, notice on security interests can be given in three ways depending on the

kind of security device - by taking actual or constructive possession, by registration and by

giving notice to the debtor in case of choses in action. Even so, one cannot deny that England

is mostly registration based system. However, existence of more than eleven37 registers for

different types of security devices is often been criticized. This approach is said not to

facilitate efficiency of obtaining information and is recommended to be changed on the

Article-9 basis.

2.3. Enforcement of security rights

Creditors in England, as in US, can utilize right of self-help to enforce their security

interest. Differences that might be noticed in this system are due to the distinction between

equitable and legal securities. Therefore, rights of repossession of equitable mortgagee or

35 Diamond, A.L. A Review of Security Interests in Property, Department of Trade and Industry (1989) 36 Gerard McCormack, Secured Credit under English and American Law, Series: Cambridge Studies in Corporate Law (No. 3), University of Manchester Published June 2004 37 See Tajti, 246

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chargee can only be used if provided for in the debenture38. Even though right of sale and

foreclosure exist in the system, foreclosure is not often used because it requires a court order

which can take a lot to be issued.

A method of self-help that is peculiar for England is appointment of a receiver, who

can be given large powers by debenture deed, such as a power to run a business of a debtor or

dispose of his business on a going concern basis39.

Creditors in England are also provided with very powerful ex parte measures such as

Mareva injunction or Anton Pillar order40 which are designed to circumscribe debtor’s efforts

of moving all the assets out of creditor’ reach. Coupled with efficient means of self-help,

these measures provide for efficient protection of creditor and clearly emanate legislator’s

efforts to protect rights of credit suppliers.

2.4. Types of available securities

English law on secured transactions is full of differences that exist between various

kinds of securities. Main differences recognized by the system are41:

1. distinction between legal and equitable securities,

2. possessory and non-possessory security interests,

3. consensual and non-consensual.

Distinction between legal and equitable securities is a peculiar feature of the English

law on security interests. This distinction stems from historical distinction between courts in

common law and courts in equity. Equitable securities are very easily created, for example,

mere agreement to create a legal mortgage gives rise to an immediate equitable mortgage. On

38See Tajti 248 39 S.44 (1) Insolvency Act 1986 40 Mareva injunction is seen as one of the most powerful devices the creditor can have; it freezes the assets of debtor pending further order or final resolution by the court. It can be obtained in a form of a worldwide injunction. Anton Pillar order is made to help gathering evidence and help discovery in general. 41 Ibid. at 39

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the contrary, creating legal security interests require registering it. However, equitable

mortgage is easily defeatable by the existing legal mortgage, at the same property.

Non-possessory securities include equitable liens, mortgages and charges while

pledge and the common law lien are possessory securities.

Security interests created by contract between parties are deemed to be contractual,

such as pledge, charge and mortgage whereas liens that arise by operation of law are non-

consensual securities.

Even though English law recognizes broad range of security devices largely utilized

by banks, the most distinguishing security right is that of the floating charge. Since floating

charge is the most discussed security device and it seems to be of interest even to countries

which barely began to regulate their secured transaction regulations, it is going to be

described in more detail below along with fixed charge with which it has multiple crossing

points.

2.4.1. Fixed Charges

Fixed charge is created over an identifiable asset, although it need not be in existence

at the time the charge was created. The main characteristic of a fixed charge is that the

company that has assets encumbered by a fixed charge is not at freedom to deal with them

without the agreement of the chargee (usually a bank). Fixed charges are suitable for

encumbering permanent capital structure of a company, like land, plant or machinery. The

creditor will endeavor to have a fixed charge since it confers to him a stronger bargaining

position.

2.4.2. Floating Charges

A company may have assets that are not suitable for granting a fixed charge. The

reason behind it is a the fluctuating nature of the asset (for example, raw materials or stock in

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trade) or impracticability to require permission of the debenture holder every time chargor

needs to deal with charged assets. It is designed to cover broadest range of assets such as land,

all kinds of movable property, intellectual property, etc. Floating charge enables debtor to use

charged assets in the ordinary course of business, generating the profit to repay the loan which

is a benefit desired by any creditor.

The company can continue to deal with the assets upon the event that is named in

debenture crystallization event. Crystallizing event that is usually specified is a default in the

repayment of principal or interest. However, parties may agree upon any event allowed by

law such as the winding up of a company, the appointment of a receiver or cessation of a

company’s business. When a floating charge crystallizes it turns into equitable fixed charge.

Upon crystallization the company loses the right to deal with the assets in the normal course

of business.

Once the crystallization occurs, priority question between fixed and floating charge

is set by “first in time” rule according to the time of registration of the charge. However,

registration is not seen as exclusive means of providing notice of existence of the floating

charge. That is why some further acts has to be performed, such as an appointment of receiver

and filing his appointment as required by s. 405(1) of the Companies Act 1985 or taking

possession .

The essential difference between a fixed and a floating charge is existence of

proprietary interest of a fixed charge in the assets so that until the loan remains unpaid, only

chargee can give permission to release the assets.42 By contrast, under a floating charge, the

chargee’s interest is an interest in a circulating assets and unless and until the chargee

intervenes (upon crystallization) company and not the bank, decides how to run its business.

42 James Hanlon, Spectrum Plus And Book Debts: The Final Chapter?, Web Journal of Current Legal Issues (2006), 1 WEB JCLI, available at http://webjcli.ncl.ac.uk/2006/issue1/hanlon1.html (visited March, 25, 2010)

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For dealing with the asset in the ordinary course of its business chargor does not have to

obtain the consent of the creditor.

2.4.3. The Relevance of the Distinction

A most important reason for distinguishing between a fixed and floating charge is

that, generally, a fixed charge will have a priority right over a floating charge. This is

particularly important in the case of insolvency of a company, where preferential debts run

ahead of the floating charge but not of the fixed charge.

Another disadvantage of a floating charge is that it may be invalid if granted within a

specified period before starting of any insolvency proceedings43. In some cases this period is

twelve months prior to the onset of the chargor’s insolvency but in cases involving

“connected persons” that period is extended to two years.

Perhaps the crucial disadvantage of a floating charge is that the fluctuating value of

the assets does not confine a certainty of the satisfaction of creditor’s claims. The amount

available for satisfaction of debts is seen only once the charge crystallizes.

2.5. Practical problems with the concept on example of Book Debts

Book debts, uncollected debt owed to a company and realized proceeds of such a

debt are often the largest asset owned by a company. Actually, some companies (e.g. those in

service industries) may have only book debts as available collateral.

At first sight, book debt seems to be appropriate as a subject of a floating charge

since it is an asset that fluctuates all the time. However, it is the general priority position of a

floating charge that makes it less attractive for a creditor to take such a security. Therefore

creditors will try to draft such a debenture that would grant them a right of a fixed charge over

book debt. Nevertheless, even though debenture bears a label of a fixed charge, a court may

43 s.245 Insolvency Act 1986

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conclude that in fact, the parties have in fact created a floating charge44. In deciding the matter

most decisive factor is degree of control on the disposal of the book debt prior to collection.

Thus, if the control is interpreted to be sufficient (meaning that the company was only

permitted to receive payment of book debts and could not assign, factor, discount, sell, charge

or otherwise deal with them) the charge is deemed to be fixed. Once the collected book debts

are paid into a bank account, a company could not be granted unrestricted access to that

account. In case the company was able to draw on its account as it wished, charge should be

characterized as a floating charge.

2.6. Further steps

The big drawback of this approach to the book debt is lack of legal certainty. Courts

gave little guidance on how much control should be utilized by banks in order for debenture

to create a fixed charge. Lack of predictability in the area called for “desirability of

legislation in the area”45. Recommendations for legislating this field have already been made

by the Law Commission for England and Wales46. New system will treat all the charges over

book debts as floating charges.

44 See Re Yorkshire Woolcombers [1903] 2 Ch 284 , Siebe Gorman and Co Ltd v Barclays Bank Ltd[1979] 2 Lloyd’s Rep 142, New Bullas Trading[1994] 1 BCLC 449, Spectrum Plus [2005] UKHL 41 45 See Are Charges Over Book Debts Fixed or Floating? The English Court of Appeal’s Decision in Spectrum, THE WORLD BANK GLOBAL INSOLVENCY LAW DATABASE (Clifford Chance L.L.P., London, Eng.) 46See Lauren Pogue, The Spectrum Plus Case: Fixed or Floating Charges over Book Debts in England? at 438 available at http://studentorgs.law.unc.edu/documents.ncbank.volume9.laurenpogue.pdf

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3. GERMANY

3.1. Legal environment

Germany is one of the world’s most advanced economies. However, its financial

system is based on building blocks quite different from the one UCC is based on. Thus,

Germany can be described as concentrative bank oriented financial system, rather than

dependant on the stock-market. Having been the major players on the market, banks are

naturally very closely tied to businesses that are limited in their borrowing options. This long-

term relationship between banks and companies have a number of advantages for bank, such

as timely access to information and possibility of monitoring affairs of the firm.

Nevertheless, legal regulation and underlying philosophy of the German law of

secured transactions are not as business-friendly as its US counterparts. Courts were

concerned about supposedly unfair advantage of banks and created priority rules that

generally disadvantage banks 47 .Spectrum of possible collateral utilized by banks is closed by

typically civil concept of numerus clauses rights. The only statutory security device is still

the possessory pledge which is highly unsuitable to entertain needs of modern business

financing. Being unable to create security devices that would give the creditor in rem rights,

parties, using the consensual freedom, created number of security devices latter supported by

judiciary. Therefore, along with the established statutory security devices such as suretyship,

security provided by negotiable instruments, mortgage, pledge of movables and rights, new

contractual types of security devices, known as “kautelarische Sicherheiten” began to be

largely utilized. Having been the genuine product of German secured transaction law highly

influential to number of other civil law systems, including Serbia48, more attention will be

47 Haussmann, Jens, The Value of Public – Notice filing Under Uniform Commercial Code Art.9: A Comparison with the German Legal System of Securities in Personal Property, 25 GA.J.INT’L&COMP. L.427 (1996) at 474 48 Serbian Draft Code on Ownership and Other Property Rights is about to introduce fiduciary transfer and land charge as new types of securities

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given to land charge, security transfers (“Sicherungs bereignung”) and fiduciary security

assignment (“Sicherungsabtretung”).

3.2. Publicity of security devices

The peculiarity of German legal system can be best seen in the way it copes with

“the false wealth problem” inherent to the non-possessory securities. It embraced registration

hostile system that is relying on the closed list of in rem rights in property enumerated in

codes to give publicity to rights in pledged collateral. In this way, creditor’s can obtain

information on previous encumbrances on collateral only from debtors, which negatively

affects credit decisions49. This problem was not seen as a major drawback to the rights of

creditor since personal property was not a strength on which the assets were borrowed to the

debtor. Even though times has changed and German banks start to utilize personal property as

collateral there is no reform plans that envisage shift to the registration based system50.

However, problems which this kind of approach already caused to the German financiers will

perhaps cause changes in the future51.

3.3. Enforcement of security rights

The only way of enforcing security rights in Germany still goes through the courts.

Yet, one of the features of the efficient credit economy is precisely a possibility of prompt

realization of pledged collateral. Since self-help, which is seen as most effective means for

achieving this goal, is not in use in Germany, pre-trial measures are observed as good

substitute. Thus, most widely used pre-trial measures in Germany are those named “Arrest”

and “einstweilige Verf gung”. While “Arrest” is a prejudgment order securing enforcement of

monetary claims of the applicant, ”einstweilige Verf gung” secures all types of non-monetary 49 Tajti at 290 50 See Id. at 291 51 See Hongkong and Shangai Banking Corp, Ltd. V. HEH USA Corporation 805 F. Supp. 133 (W.D.N.Y. 1992). Here, valid security right over collateral acquired in Germany was not accepted by US courts since it was in contradiction to the filing philosophy of UCC.

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claims52. Conditions for granting these measures are similar as in other systems, therefore

applicant has to furnish evidence of existence of a right and urgency, proving that his right is

going to be in jeopardy if the measure is not granted. As opposed to not so predictive duration

of court proceedings, duration of issuing pre-trial measures is very strict – one month from the

day of application53. Yet, this kind of court based enforcement system complemented with

efficient pre-trial measures seem function quite good in Germany.

3.4. Types of security devices

3.4.1. Land Charge (“Grundschuld”)

Along with Hypothek, which is an accessory security device dependant on

underlying transaction, Land charge is more flexible and therefore better suitable for long-

term financing54. Land charge differs from Hypothek in that:

1) It is not accessory;

2) Creditor having right of land charge has priority rights in enforcement

proceedings as well as in bankruptcy;

3) Beneficiary of the land charge can be owner of the real estate as well any

security holder.

Land charge is created upon entry into the land registry. Until registration,

beneficiaries have no security right over property. Application for the registration of land

charge is made by notary, who needs to be given power of attorney from the registered owner

of the property in order to register the land charge55.

52 See Tajti at.286 53 Section 929 para. 2 of the ZPO 54 See Strohmann, Chapter on Germany, in MOOJEN &TRUIDEN, Bank Security and Other Credit Enhancement Methods: A Practical Guide on Security Devices Available to Banks in Thirty Countries Throughout the World (Kluwer Law International, The Hague,1999) supra note 23,at 162 55 David Cox, Jeremy Trinder, Ekkehard Moeser and Endrik Lettau, Security over real estate: Germany compared to England and Wales, Corporate Real Estate 2006/2007 at.22

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Land charge gives right to beneficiary to keep the registered amount from proceeds

of sale of the property. Beneficiary does not have a right to a deficiency judgment towards the

owner of the immovable, because right to a land charge does not allow for that. Owner of the

immovable can pay the registered amount to the beneficiary of the land charge and stop its

sale.

Since registration process takes considerable amount of time in Germany, the bank

can agree to drawdown a loan against a notarial confirmation that the land charge shall have

priority right after registration56. On the grant of a land charge, bank can make a request to the

notary for issuance of “immediately enforceable copy” which will enable bank to enforce its

right immediately, without going through court proceedings to obtain a legal title from the

owner of the property.

A land charge shall specify a maximum amount of loan payable to the lien holder,

which will enable bank to extend the amount of credit without having to obtain a new legal

charge as a security57. In case additional amount of credit granted exceeds amount registered,

land charge will also be increased and registered. A beneficiary of all subordinated registered

rights has to agree to the increase of the land charge, since they can be adversely affected by

it.

Land charges can be certified and uncertified. Certified land charges are utilized

more because its transfer is effected more easily, by way of assignation. It is not necessary to

register such an assignment. Assignation of existing certified land charge is less costly than

creation of a new charge and therefore more appealing to banks.

56 See Ibid. 57 Ibid.

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3.4.2. German Security Transfer (“Sicherungs bereignung”)

Security transfer is essentially the transfer of the ownership over the collateral to the

transferee in trust, for a limited period of time and for the purpose of security (constructive

possession). Security transfers always involve a type of fiduciary ownership. Accordingly,

even though a transferee acquires the full ownership on the transferred rights, it is just

temporary and only for security purposes58. The security giver retains actual possession. The

ownership of the trustee is never a full ownership because his rights are restricted by the

purpose of the security. This security is based on a simple agreement, which need not be in a

particular form. This agreement would be normally valid only between parties. Consequences

of this are especially visible in the bankruptcy setting where the secured party is treated as a

mere pledgee entitled to only separate satisfaction.

Security transfer is not regulated, but rather based on customary law. Also, it is

founded on BGB principles such as constitutum possesorum and the rules of trust law59.

Three basic forms of the security transfer are simple, extended, expanded.

Expanded security transfer means that security given to the bank secures not only the

debt originally made but also any other debts burdening the original debtor on other

grounds60. In this way, one collateral secures several credits.

Extended security transfer means that the bank`s security interest automatically

attaches to goods that are result of processing of the initially encumbered collateral61. Then

the bank authorizes the debtor through a selling clause to transfer the goods in his own name

to purchasers and to collect the price from them in his own name. However, advanced

assignment of all such proceeds is required.

58 See Serick, Rolf Securities in Movables in German Law: An Outline (Kluwer Law and Taxation Publishers, Deventer 1990 ), supra note 19,at 23 and HAUSMANN ,supra note 241,at 459 59 See Serick supra note 19,at 32 60 See Tajti at 279 61 Ibid.

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Extended and expanded devices are equally non-registrable and are therefore

essentially secret transactions.

When used in combination, these clauses will have the effect of the English floating

charge and enable the bank to encumber all the present and future assets of a debtor.

3.4.3. Fiduciary security assignment (“Sicherungsabtretung”)

Creation of fiduciary security assignment came as a response to provisions of BGB

on security assignments, which require a notification of the account debtor in order for it to be

valid62. This requirement was overcome by introduction of fiduciary security assignment

which provided that a contract between assignor and assignee alone is enough to enforce such

a security interest63.This also enabled pledging future rights as collateral.

Fiduciary nature of this assignment restricts the rights of an assignee since they are

limited in time and serve for the security purposes only.

Even though through practice many kinds of assignment were developed64, bulk

assignment (“Globalzession”) is most commonly utilized by banks, because it can encompass

all the present and future claims. In case a bulk assignment competes with a latter advance

assignment to a supplier extending his reserved ownership, latter interest deserves priority

right.

62 See s.1280 BGB 63 See §398 BGB 64 For example, accessory assignment (“Anchlusszession”) which is an advanced assignment used to assign a right in the price of goods as well as covering assignment (“Mantelzession”) which is assignment of future debts once they arise See Serick supra note 19,at 90-91

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Chapter III: SERBIA

1. Introduction

Banking system in Serbia has experienced dramatic changes within last few years65.

The collapse of previous regime in the end of 90`s imposed a heavy burden on banks. This

was caused by large amounts of bad loans resulting in major losses, low liquidity and distrust

of depositors. In order to cope with this heritage, Central Bank decided to consolidate the

banking sector and close weakest banks. This approach proved to be successful. The banking

sector is growing again and depositor's confidence is returning. According to the large number

of international players involved in the Serbian banking sector, banking market in Serbia

looks very promising today.

When deciding on granting credit, the most important information banks will try to

obtain is on credit standing of a client. In case client is a natural person, banks will examine

amount of his monthly wage. In case the client is a company, his financial reports will be the

basis for deciding on granting credit. Information on solvency and indebtedness of clients

became more available with the introduction of Credit Bureau which is a central, national data

base that provides credit rating details on individuals and businesses. An authorized person

from the bank, with a written consent of a client, can obtain report from Credit Bureau.

In view of efficient risk management, along with the acceptable business plan and

positive evaluation of the credit capacity , banks usually require various security instruments

that will provide additional guarantee of the repayment abilities of the client. Type of

collateral depends on duration of credit, application of credit, as well as on the solvency of the

client. By comparing various bank credit terms and conditions, one can conclude that most

often used types of collateral by Serbian banks are following:

65 Serbia Banking market 2006 - CEE banking series, available at http://www.researchandmarkets.com/reports/316374/serbia_banking_market_2006_cee_banking_series.htm (last visited March,23,2010)

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Personal securities:

1) Suretyships granted by natural or legal person are highly utilized.

2) Bank guarantees granted by domestic or foreign banks;

3) Bills of exchange as well as the promissory notes;

Real securities:

1) Mortgage ,

2) Pledge over every kind of movable asset ,

3) Assignment of receivables,

4) assignment of rights deriving from the insurance policy based on insurance

given for the object of the pledge or mortgage,

5) assignment of rights deriving from debtor’s life insurance policy,

6) Cash deposit,

7) contractual authorizations for debiting a bank account,

8) Administrative ban.66

Quasi-securities:

1) Negative pledge covenants,

2) Subordination ,

3) Set-off.

It can be concluded that Serbian banks rely on same security devices notwithstanding

the type of debtor. For long-term credits, banks tend to use what they consider to be more

solid types of collateral, such as mortgage, pledge on equipment, cash deposits, bank

66 Administrative ban is a banks form filled and certified by the authorized person in the company where the client is employed. This form is used when evaluating credit standing of the debtor since it consists of data on employment and wage of the client. At the same time, administrative ban provide means of securing credit since , in case the client stops making payments to bank, employer is obliged to pay a certain amount of wage (usually 30%) into the banking account for the purposes of repaying the credit amount.

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guarantees, etc. In case of short-term loans, where further steps in development of enterprise

are more likely to be foreseen, banks accept so–called soft collateral such as bills of exchange

and suretyships of natural and legal persons. These types of security devices will be discussed

in proportion of their importance. Since Serbian law is experiencing some transitory changes,

special focus will be on new regulation on Serbian mortgage and pledge law.

2. In personam security devices

2.1. Suretyship

Suretyship is often used as collateral in Serbian banking practice both for retail and

business crediting. This kind of in personam security right is regulated by Law on

Obligations67. It does not differ from the other jurisdiction in that it is accessory to the

principal contract concluded between the principal debtor and a creditor. A suretyship

contract is concluded between creditor and surety in writing. Subject of suretyship agreement

can be any valid claim regardless its content, even future and conditional claims.

Surety can be any person that has legal capacity to enter this obligation which means

that both legal and natural persons can be used a sureties. Having a company as a surety for a

credit of another company was widely used practice.

Surety’s obligation is seen in repaying the sum owed by the debtor in case he does

not satisfy his debt upon default. Creditor may request payment of the debt from the surety

before principal debtor defaults if it is clear that the debtor is insolvent. Once the surety

discharges the indebtedness, he is subrogated to the creditor’s rights towards the debtor.

In case surety undertook a solidary obligation towards a creditor, the creditor does

not have first to try to collect a debt from the principal debtor but may turn to the surety

immediately upon debtor’s default.

67 Published in “Official Gazette” No.29/78, 39/85, 45/89, 57/89, 31/93

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2.1.1. Practical difficulties

Even though widely used by banks, suretyship is not immune to various problems.

First of all, problems might arise when collecting the amount due from the surety if the

consent for disposal of the property is not given by his spouse or other adult members of his

household. The other problem can be seen in numerous objections available to the debtor

which include both objections available to the principal debtor as well as surety’s own

objections, e.g. right of set off, nullity of the suretyship etc.68

2.2. Bank guarantee

Bank guarantee represents a written statement by which the bank undertakes

obligation towards the beneficiary to pay a certain amount in compliance with its provisions

in case the debtor fails to meet his obligation. It is regulated by the Law on Obligations which

prescribes written form for its validity.

Bank guarantee establishes legal relationship between at least three persons-creditors

and debtors form the principal contract, bank and drawer (debtor from the principal

obligation) and bank and beneficiary (creditor from the principal obligation). More than one

bank can be included in this type of transaction which further complicates relationship

between parties to the guarantee.

Bank guarantee is a security device which is used very often in business transactions.

Its main advantage is seen in its prompt and efficient enfrcement. It provides for a greater

degree of security than suretyship because bank as an institution is a guarant for debtor's

obligation.

68 See Art. 100 Law on Obligations

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2.3. Bill of exchange69

Bill of exchange is regulated by Bill of Exchange Act70. Rules contained in the Law

are based on the Genevan Convention Providing a Uniform Law For Bills of Exchange and

Promissory Notes and regulations in force in other countries with whom Serbia performs

commercial transactions.

In practice, the most common are two types of bills of exchange-promissory note and

bill of exchange.

From the simplified point of view, promissory note71 is a certain variant of a credit

paper. In substance it is a promise of a drawer to pay to a creditor (payee) certain financial

sum. As a rule, a promissory note therefore contains characteristic expression “I will pay”.

Basically, it has only two participants – drawer and creditor (payee). The drawer of a

promissory note is a direct debtor obliged by his sign to pay upon default. Owner of an

enterprise can sign a promissory not acting in capacity of natural person.

Opposed to that, the bill of exchange is distinguished from the note above by the fact

that, in its basic form, it requires higher number of participants. Beside drawer and payee,

another participant-drawee is included. Substance of a bill of exchange is in payment order of

a drawer to a drawee to pay a certain financial sum to a payee. As a rule, a bill of exchange

therefore contains characteristic expression “Pay to”.

Most often utilized by banks are blank promissory notes with a “no protest” clause.72

Along with the note banks require client to sign the authorization allowing banks to fill in the

69 Term will be used as generic term encompassing both promissory note and bill of exchange. 70 Published in the ”Official Gazette FNRJ“, No. 104/46 and 16/58, “ Official Gazette SFRJ“, No. 16/65, 54/70 and 57/89 and “ Official Gazette SRJ“ br. 46/96 71 Promissory note in systems based on Genevan conventions differs significantly from the common-law one. The common law promissory note contains very extensive details of principal transaction and in order to execute payment according to the note creditor has to prove that he fulfilled his obligation from the underlying transaction. Opposed to that, in the “Genevan” type promissory note its abstract nature is seen as its basic feature and main advantage. 72 “Protest“ represents a document issued by court confirming that measures pointed at satisfaction of debt have been done as well as whether they led to the satisfaction of debt or not.

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amount of debt due along with additional costs. Once the debtor pays out the amount of debt,

bank returns the promissory note to him.

The reason why bill of exchange seems so appealing to the banks is a possibility of

simplified and prompt enforcement.73 When enforcing his claim, creditor is freed from

proving the actual basis of debt which significantly shortens the time needed for debt

collection. If the debtor does not comply with his obligation within the deadline contained in

the bill of exchange, creditor has a right to proceed with enforced collection of claims.

Enforced collection of debt is directed towards all the accounts of the debtor based

on creditor’s authorization. The priorities are determined according to time the bill of

exchange is delivered to the bank by the creditor. If there is not enough assets on the accounts

of the debtor in the bank named in the bill of exchange as a place where payment should be

executed , the banks sends data to the National Bank of Serbia in order to block all the

debtor’s accounts in all the banks .

Once the debtor’s account is blocked, the enforcement of claims based on bill of

exchange is done according to the time of the acceptance of the executive orders. Thus,

enforcement of claims is not stopped even if the debtor’s account is blocked. The bill of

exchange has third priority rank and comes after payment of taxes and other public debts as

well as after debts based on court orders.

2.3.1. Practical implications

Even though conceived as means of prompt satisfaction of debt, in practice there is a

growing number of bills of exchange that cannot be enforced. Nowadays, bill of exchange is

seen as collateral that cannot provide much security to the creditor and it is often used in

combination with other types of collateral. Problems with this type of security are visible in

73 In these kinds of proceedings, debtor’s right of objection and appeal is very limited and the deadlines for bringing them up are shortened (8 days, as opposed to the general 15 days rule).

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case there are not enough assets on the blocked accounts which can lead to enforcement

proceedings lasting two years or more.

For that reason a National Bank of Serbia proposed amendment to the Law on

Payment transactions74. Amendment will introduce a public register of promissory notes and

authorizations which will enable companies to have an insight into how many promissory

notes their partners have already issued. If this proposal would be accepted, the enforced

collection of claims would be executed once a day, proportionate to the amount of debt owed

to the creditor and not according to the priority of the order, as the case is now. The

possibility of payment of the wages and other income when the account is blocked will be

cancelled. The enforced collection will be directed towards the account where the debtor has

the most of assets and it will proceed respectively according to the amount of assets. Also, if

the account owners do not inform the bank on their statutory and other changes, it will impose

prohibition of the free disposal of the assets from their accounts and, in case this information

is not provided within three month time, these accounts will be cancelled.

3. In Rem Security Devices

3.1. Security interests on Immovables

3.1.1. Mortgage (Hipoteka)

New legislation regulating this security introduces a lot of novelties into the field and

make mortgage on immovables even more appealing to the banks. Serbian Mortgage Act 75

defines mortgage as a lien on real estate, which empowers creditor to satisfy his claim from

the value of the immovable before non-secured and junior mortgage creditors, regardless of

74 Published in Official Gazette No 43/2004,62/2006 75 Published in the “Official Gazette RS”, No. 115/05 of 27 December 2005. One caveat has to be added regarding the English term mortgage used here. Here, the mortgage doesn’t mean a transfer of ownership of the asset by way of security upon condition that it will be re-transferred once the debt is paid. Mortgage used in this sense means solely a “lien“ on the real property, a jus in re aliena.

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the actual possession of immovable.76 This means that the mortgage is in rem security right

which gives the creditor a priority in satisfaction and a right of pursuit. It is an accessory

security dependant on the existence of the debt it secures.

3.1.1.1. Subject of a mortgage

The way in which the subject of the mortgage is defined is influenced by issues lying

beyond the field of mortgage law. One of them is certainly the socialist legacy which is

visible in many substitutes of ownership rights in movables, such as various kinds of rights of

disposition, right of use, right of priority construction, etc. The other reason is lack of unitary

regulation on immovables .Construction land is still state owned but buildings are considered

to be part of private property. Illegal building is also a problematic zone. There is a vast

number of buildings that are either built without any permit or still missing a usage permit and

therefore cannot be registered. Besides attempts to legalize this building, state has strong

incentive to activate the inherent credit value in them.

Art.3 of the Mortgage Act enumerates immovable that can be used as a collateral.

Thus the mortgage can be created upon:

1) an immovable property (title to land, building and the like);

2) a part of a real estate property, in accordance with the decision on partition;77

3) a portion in a common immovable property;

4) a separate part of a building in tenure, and/or some other right containing the

right of disposal (a dwelling, business premises, garage, parking space, etc.)78;

76See Art .2 of the Mortgage Act 77 This provision introduces a rule which is opposite to the one suitable for the systems based on public land registers. According to traditional rule, a part of a real estate property can only become subject of a mortgage once the partition is done in the land register which is a consequence of the concept of unity of mortgage and the fact that it is created by filing in the register. In this way a non practical solution is created, because it is not possible to register a mortgage on a part of a real estate until an official partition is completed. 78 A mortgage on the ideal portion in a common immovable property can be established without approval of the rest of co-owners except if the mortgage is created on the ideal portion of the object under construction when the consent of all the co-owners is needed.

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5) a right to land authorizing the free legal disposition, including in particular the

right of construction, right of priority construction or disposition in government

and/or social ownership;

6) a building under construction, as well as a separate part of a building under

construction (a dwelling, business premises, garage, etc.), irrespective of

whether completed or not, provided that a valid building permit has been

issued in conformity with the law governing the building construction.

The subject of the mortgage can also be a non- registered immovable in case it

complies with certain conditions imposed by banks and National Corporation for Securing

Housing Loans79 which insures loans secured on the strength of this security and in that way

enhances chances to obtain bank credit.

Solutions included in the Act regarding the subject of the mortgage are completely in

accordance with the principle of specialty of a mortgage as an in rem right. However, the Act

introduced a number of novelties. The most important novelty includes the possibility of

mortgaging an object under construction as well as a part of a real estate property under

construction regardless of the fact that it is not yet built as long as the valid building permit is

issued.

3.1.1.2. Mortgage on object under construction

The need for this solution is emphasized by the fact that the Serbian law did not

recognize the principle superficies solo cedit80 in the areas with the construction land. Up till

the enactment of the Constitution of the Republic of Serbia81 the construction land in cities

could only be in governmental or social ownership. The re-establishment of the unity of 79 Available at http://www.nkosk.co.rs/code/navigate.asp?Id=5 (last visited, march,23,2010) 80 The principle can be described as “everything what is built on the land (buildings) belong to the owner of the land” 81 “Official Gazette RS” No. 98/2006

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immovable infringed during the socialist times by the nationalization of the building land

cannot be achieved. Since the owners had a right to build and own buildings and there parts

(i.d. flats) they were entitled to a right of permanent use of land. Since enactment of the Law

on Planning and Construction82 the unfledged governmental land can be leased for the

purposes of building (which is the equivalent of the right of building).

However without rights in the land, investors did not have anything to mortgage till

the building was not completed and registered. The pressure of the international

organizations, which did not completely understand reasons for inability to pledge an object

under construction, was directed towards on the one hand allowing investors to obtain credits

for the building and on the other hand enabling buyers to get credit by encumbering the flat

they are buying. This idea was backed up by a commercial logic but the legal obstacles were

clearly not considered much.

In case of the object under construction, mortgage is created by filing the appropriate

notice on the land registry regarding the object which is being built. Once the construction is

over, a mortgage over that object is filled ex officio. Until this conversion, the mortgage on

the object under construction is created by transferring a valid building permit. The issuer of

the building permit is obliged to cancel the old and issue a new permit for the transferee of the

permit83. Even though this solution has enabled encumbering objects under construction, it

brought a major inconsistency into the Serbian legal system. It made a public subjective right

(the building permit) which is issued in the administrative proceedings transferrable, while it

is well established that negotiability is a characteristic of a subjective legal rights. Therefore,

this kind of solution should be regarded as only temporary.

82 Published in “Official Gazette ” No. 47/2003-1 and 34/2006-3 83 See Art.39 Mortgage Act

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3.1.1.3. Scope of the mortgage

Mortgage is construed to cover all the component parts of the immovable, products

(if the opposite is not contracted for), accessories, as long as provided in the contract, and all

the latter improvements and enhancements in the value of collateral.

Each and every claim can be secured by means of mortgage -monetary, non-

monetary, in domestic or foreign currency .The mortgage can be furnished for a future and

conditional claim which can be seen as an exception from the principle of the accessoriness of

a mortgage. However, it can be noticed that in that case the Act does not include provision

regarding filing of a maximum amount of claim which can be seen as a serious draw-back of

the Act since it could provide for larger use of this type of collateral in bank loans. Even so,

provisions on filing the maximum amount of the claim exist in other acts84 so its

implementation in practice is possible.

3.1.1.4. Types and creation of mortgage

According to legal basis, the Act recognizes:

1. contractual mortgage, which is created by contract or a settlement before

court;

2. unilateral mortgage, that is created by the statement of the mortgagor;

3. statutory mortgage;

4. judicial mortgage created by a court’s decision.

In practice, banks use most often first two types. In each case, the mortgage is

created upon filing in register. Filing may be described as “transaction filing” because filing

of the document underlying transaction is also required.85